Well, I'd say this is a good development. It looks less likely now that we will be tricked by high shelter inflation into a deflationary shock for the rest of the economy. Non-shelter core inflation seems to be trending up now.
Here are my graphs for core inflation, with and without shelter, updated. I don't think we are totally out of the woods. In some ways, I think we are basically in a similar position as late 2007, but without the housing boom. Then the Fed appeared to be loosening, and inflation recovered while the economy appeared to be stabilizing. But, by the end of 2008, we discovered that things weren't nearly as stable as we had thought.
I think something like that is still a possibility. It is still the case, as it has been for the better part of 20 years, that inflation is being pushed up by supply constraints in the housing market. This will still cause the Fed to tighten monetary policy to a level below their stated targets. Since 1997, non-shelter inflation has really fluctuated around a stable trend of about 1.5%, generally moving between 1% and 2%. But, the Fed stance has shifted to a more hawkish posture, which seems to treat 2% as an inflation ceiling. If shelter inflation remains above 3%, Core minus Shelter inflation may range even lower as we move forward.
I think the market tends to share this concern. Friday, the Eurodollar yield curve flattened somewhat on the news. The short end of the curve moved up about 3 basis points, but the long end of the curve moved down up to 5 basis points. My model had shown an expected second rate hike as late as the end of 2017, last week. This has moved back to about April 2017 now. But, the slope of the curve after the hike continues to flatten. It is so low that now, after the expected rate hike of April 2017, rates are expected to rise by only 1/4% per year! This is essentially a flat yield curve. I hope there is enough strength in the economy for recovery to continue. Recent dovish comments from some Fed members are heartening.
Here are some long term graphs of shelter inflation, by region. The two Americas come across pretty clearly here. The first graph is the ratio of Shelter price levels to the price level of Core CPI less Shelter. Rent prices in the Midwest and the South have risen fairly closely to Core CPI prices.
The Northeast has had unusual rent inflation since the late 1980s. Rent inflation was pretty normal in the West, along with the South and the Midwest, until the mid-1990s. This is when the urban housing shortage kicked into gear. Since the mid-1990s, rents in the West have grown at a faster rate and have been more volatile than the other regions.
The last graph shows Trailing 12 month Shelter inflation for each region. Here we can see that rent inflation shot up in all regions after housing starts collapsed in 2006, though the Midwest didn't rise quite as sharply. Regional rent inflation tends to move somewhat independently. But, at the beginning of 2006, there was a singular outside force that caused rent inflation to shoot up across regions at a similar scale. A sharp negative shock in credit markets caused a sharp negative shock in housing supply. Then, by mid-2007, the credit crisis had begun to drive home prices down, leading to defaults and foreclosures. By then, households were sharply reducing their housing demand because they were literally losing their houses, and moving into whatever unit they could manage. This sharp decline in rent inflation, and the initial recovery from it, were also both quite uniform.
Now, we are going back to a context where regional differences are more important, and rents in the West are shooting up more than in the other regions, although our continued War on Credit means that there is a lack of supply in all regions, so rent inflation is high in all regions.